The practice of fixing the variable metal price portion of aluminum semi’s is well established among metals manufacturing buyers. Often termed resting orders or fixed price orders, buyers with reasonably dependable volumes will often fix prices forward if they feel there is a probability prices will increase or if they simply want to lock in an existing profit margin against a fixed price sale. We saw several cases in the second half of last year where buyers had locked in prices with producers only to see the metal price crash and volumes decline. As a result, these companies have been further hampered managing the existing recession by having to work through contracts at what are now historically high prices for periods way beyond the original expectation ” due to the reduced volumes.
So it is not too much of a surprise to see Alcoa announce as part of their recent cost re-structuring and liquidity measures that they will require (starting March 16) that buyers entering into all fixed priced contracts will have to enter into a Collateral Sales Agreement, CSA, to cover the variable risk. Alcoa will enter into a firm price sales contract with customers and separately will have a CSA attached covering the London Metal Exchange LME portion of the pricing. According to Platts, companies will be required to put up collateral to cover potential changes in the LME price compared with the price at the time the contract was negotiated. Alcoa will negotiate with each customer to set individual thresholds of exposure Alcoa is willing to accept on their account before the margin kicks in. Here’s the rub for buying organizations already strapped for cash in the face of tight margins, falling volumes and banks unwilling to extend credit facilities – under the CSA they will be required to pre-pay a margin to cover the LME portion of the purchase price if the price drops. The buying organization will need to continue to support the increased risk of the producer. In many ways it is surprising mills have not done this before, where mills pass the fixed price element as a firm futures contract. So far, Alcoa says they have not had customers renege on the deals but they (or their risk management team) are concerned that in these troubled times a growing number of their clients may fail and Alcoa will be left with the exposure on their books.
One can assume distributors will pass on this requirement to their customers, requiring a layer of control, paperwork and management they do not currently incur. On the flip side, it will significantly reduce the distributors risk too as under the previous arrangement the distributor would have been left with the exposure if their end-user went down or failed to honor the fixed price contract.